update: the venezuelan economy in the chavez years

8/14/2019 Update: The Venezuelan Economy in the Chavez Years

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Update:TheVenezuelanEconomyintheChvezYears

MarkWeisbrotandLuisSandovalFebruary2008

Center for Economic and Policy Research

1611 Connecticut Avenue, NW, Suite 400

Washington, D.C. 20009

202-293-5380

www.cepr.net
http://www.cepr.net/http://www.cepr.net/http://www.cepr.net/


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Center for Economic and Policy Research, February, 2008 2

ContentsExecutive Summary ...........................................................................................................................................3

Introduction........................................................................................................................................................5

Economic Growth.............................................................................................................................................5

Social Spending, Poverty, and Employment................................................................................................10

Fiscal and Monetary Policy, Exchange Rates, Balance of Payments, and the Sustainability of theCurrent Economic Expansion .......................................................................................................................15

Conclusion ........................................................................................................................................................23

About the Authors

Mark Weisbrot is Co-Director and an Economist and Luis Sandoval is a Research Assistant at theCenter for Economic and Policy Research in Washington, DC.

Acknowledgements

The authors would like to thank Dean Baker, Rebecca Ray, and Dan Beeton for their comments,and Kunda Chinku for editorial and research assistance

.


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Update: The Venezuelan Economy in the Chvez Years 3

ExecutiveSummaryVenezuela has experienced very rapid growth since the bottom of the recession in 2003, and grew by10.3 percent in 2006 and about 8.4 percent last year. The most commonly held view of the currenteconomic expansion is that it is an "oil boom" driven by high oil prices, as in the past, and is headedfor a "bust." The coming collapse is seen either as a result of oil prices eventually declining, or the

government's mismanagement of economic policy.

There is much evidence to contradict this conventional wisdom. Venezuela suffered a severeeconomic growth collapse in the 1980s and 1990s, with its real GDP peaking in 1977. In this regardit is similar to the region as a whole, which since 1980 has suffered its worst long-term growthperformance in more than a century. Hugo Chvez Fras was elected in 1998 and took office in1999, and the first four years of his administration were plagued by political instability that had alarge adverse impact on the economy. (See Figure 2 ). This culminated in a military coup thattemporarily toppled the constitutional government in April 2002, followed by a devastating oil strikein December 2002-February 2003. The oil strike sent the economy into a severe recession, duringwhich Venezuela lost 24 percent of GDP.

But in the second quarter of 2003, the political situation began to stabilize, and it has continued tostabilize throughout the current economic expansion. The economy has had continuous rapidgrowth since the onset of political stability. Real (inflation-adjusted) GDP has grown by 87.3 percentsince the bottom of the recession in 2003. It is likely that the government's expansionary fiscal andmonetary policies, as well as exchange controls, have contributed to the current economic upswing.Central government spending increased from 21.4 percent of GDP in 1998 to 30 percent in 2006.Real short-term interest rates have been negative throughout all or most of the recovery (dependingon the measuresee Figure 4).

The government's revenue increased even faster than spending during this period, from 17.4 to 30percent of GDP over the same period, leaving the central government with a balanced budget for

2006. The government has planned conservatively with respect to oil prices: for example, for 2007,the budget planned for oil at $29 per barrel, compared to an average price of $65.20 dollars perbarrel for Venezuelan crude last year. The government has typically exceeded planned spending asoil prices come in higher than the budgeted price, so it is possible that spending would be reduced ifoil prices decline.

However, Venezuela has a large cushion of reserves to draw upon before an oil price decline wouldbegin to squeeze its finances. A decline in oil prices of 20 percent or more could be absorbed fromofficial international reserves, which at $34.3 billion at the end of last year (2007) are enough to payoff all of Venezuela's foreign debt. This does not include other government offshore accounts,which are estimated at as much as $21.5 billion. With its low foreign debt (11.4 percent of GDP),the government could also tap international credit markets in the event of an oil price decline.Furthermore, a collapse of oil prices does not appear to be likely in the foreseeable future. TheJanuary 8 short-term outlook of the US Energy Information Agency projects oil prices (WTI crude)at $87.21 per barrel for 2008 and $81.67 for 2009, compared to an average price of $72.3 for 2007.

The risks of unanticipated supply shocks especially in the volatile Middle East seem to be mostlyon the downside, which would increase prices.

The Chvez government has greatly increased social spending, including spending on health care,subsidized food, and education. The most pronounced difference has been in the area of healthcare. For example, in 1998 there were 1,628 primary care physicians for a population of 23.4million. Today, there are 19,571 for a population of 27 million. The Venezuelan government hasalso provided widespread access to subsidized food. By 2006, there were 15,726 stores throughout


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the country that offered mainly food items at subsidized prices (with average savings of 27 percentand 39 percent compared to market prices in 2005 and 2006, respectively).

The central government's social spending has increased massively, from 8.2 percent of GDP in 1998to 13.6 percent for 2006. SeeTable 2. In real (inflation-adjusted) terms, social spending per personhas increased by 170 percent over the period 1998-2006. But this does not include PDVSAs social

spending, which was 7.3 percent of GDP in 2006. With this included, social spending reached 20.9percent of GDP in 2006, at least 314 percent more than in 1998 (in terms of real social spending perperson).

The poverty rate has been cut in half from its peak of 55.1 percent in 2003 to 27.5 percent in thefirst half of 2007, as would be expected in the face of the very rapid economic growth during theseyears. (SeeTable 3). If we compare the pre-Chvez poverty rate (43.9 percent) with the first half of2007 (27.5 percent) this is a 37 percent drop in the rate of poverty. However this poverty rate doesnot take into account the increased access to health care or education that poor people haveexperienced. The situation of the poor has therefore improved significantly beyond even thesubstantial poverty reduction that is visible in the official poverty rate, which measures only cashincome. Measured unemployment has also dropped substantially to 9.3 percent in the first half of

2007, its lowest level in more than a decade; as compared to 15.3 percent in the first half of 1999and 19.2 percent in the first half of 2003 (coming out of the recession). Formal employment has alsoincreased significantly since 1998, from 45.4 to 50.6 percent of the labor force. Perhaps mostimportantly, employment as a percentage of the labor force has increased by 6 percentage pointssince the first half of 1999, which is quite substantial. (Since 2003, it has increased by almost 10percentage points).

The main challenges facing the economy are in the areas of the exchange rate and inflation. TheVenezuelan currency is substantially overvalued. The government is reluctant to devalue because thiswould raise inflation, which is currently running at 22.5 percent and exceeds their target. Since thereare exchange controls and the government is running a large current account surplus (7 percent of

GDP), there is nothing that would force a devaluation in the near future (as for example, thecurrency collapses in Argentina, Russia, and Brazil in the late 1990s). But this poses an intermediate-run problem, since even if inflation is stabilized and begins to be reduced, current rates of inflationwill continue to appreciate Venezuela's real exchange rate. This makes imports artificially cheap andnon-oil exports too expensive on world markets, hurting the tradable goods sector and eventuallybecoming unsustainable. It also makes it extremely difficult for the economy to diversify away fromits dependence on oil.

Inflation itself is a problem, now running at 22.5 percent. But it should be emphasized that double-digit inflation rates in a developing country such as Venezuela are not comparable to the samephenomenon occurring in the United States or Europe. Inflation in Venezuela was much higher inthe pre-Chvez years, running at 36 percent in 1998 and 100 percent in 1996. It has fallen through

most of the current recovery, from 40 percent annual rate (monthly, year-over-year) at the peak ofthe oil strike in February 2003 to 10.4 percent in May 2006, before climbing again to its present rate(see Figure 3).

Because of its large current account surplus, large reserves, and low foreign debt, the governmenthas a number of tools available to stabilize and reduce inflation as well as eventually bring thecurrency into alignment without sacrificing the growth of the economy. It appears the governmentis committed to maintaining a high rate of growth, in addition to its other goals. Venezuela is alsowell-situated to withstand negative external shocks, including a likely U.S. recession or even a seriousglobal slowdown, a significant drop in the price of oil, and problems in the international credit andfinancial system. Therefore, at present it does not appear that the current economic expansion is

about to end any time in the near future.


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IntroductionLike almost everything surrounding Venezuela, discussion of Venezuela's economy is almost alwayspolarized, with emphasis generally on the negative. For example, for almost two years, major U.S.media outlets, as well as more specialized publications1 stated that poverty had increased under theadministration of President Hugo Chvez. This was false, but the media did not correct its reporting

until the Center for Economic and Policy Research published a paper on the subject.2

This brief overview takes a look at Venezuela's economic performance over the last eight years,examining the major economic indicators, fiscal and monetary policy, the foreign sector, socialspending and programs, poverty, and other policy issues. The authors hope that it will contribute toclarifying some of the important issues surrounding this controversial subject.

EconomicGrowthMany accounts of the Venezuelan economy today dismiss the country's current rapid economicexpansion as an "oil boom" that will end in a disastrous bust, similar to what happened in the 1970s

and early 1980s.3 It is therefore worth looking at Venezuela's growth in both current and historicalperspective to see if there is any basis for this commonly held view.

Latin America as a region has suffered a sharp slowdown in economic growth since 1980, fromwhich it has yet to recover. For the 26 years from 1980-2006, per capita GDP has grown only about15 percent, as compared to 82 percent during just the 20 years from 1960-1980. This is the worstlong-term growth performance for more than a hundred years, although the last few years haveshown a significant improvement.

Venezuela was no exception to this trend, although its decline from peak GDP in 1977 was sharperthan most of the region, and lasted longer. As can be seen in Figure 1, real GDP per capita declinedby 26 percent from 1977 to 1985. It hit bottom in 2003, 38 percent below its 1977 peak.

Since the first quarter of 2003, the economy has grown by a remarkable 87.3 percent. 4 There areseveral issues that arise when looking at this growth in both current and historical perspective.

First, it must be noted that there are serious measurement problems with the data prior to 1984. 5 Without going into all of the measurement problems, there is a general problem that in an oileconomy, consumption and therefore living standards can rise with the price of oil even as oil GDPdeclines in real terms. This is because the rising price of oil can allow the producing country to buy

1See, for example, Javier Corrales, Hugo Boss, Foreign Policy, January/February 2006; Jorge G. Castaeda, LatinAmericas Left Turn, Foreign Affairs, May/June 2006; and Michael Shifter, In Search of Hugo Chvez, Foreign Affairs,

May/June 2006.2

Mark Weisbrot, Luis Sandoval and David Rosnick, Poverty Rates in Venezuela: Getting the Numbers Right, Centerfor Economic and Policy Research (CEPR), May 2006:[http://www.cepr.net/documents/venezuelan_poverty_rates_2006_05.pdf].

3See, for example, Economist Intelligence Unit, "Venezuela risk: Risk overview," Risk Briefing Select, April 27, 2007;Chris Kraul, "Chvez's grand, risky dream," Los Angeles Times, June 23, 2007; and Jose de Cordoba, "Land Grab:Farmers Are Latest Target in Venezuelan Upheaval," The Wall Street Journal, May 17, 2007.

4See, Banco Central de Venezuela(BCV) seasonally-adjusted, quarterly GDP series in 1997 constant prices available at:http://www.bcv.org.ve/c2/indicadores.asp (under Agregados Macroeconomicos).

5See Rodriguez (2006) for a discussion of these measurement problems. Since Rodriguez' paper was written, the PennWorld Tables data was revised (version 6.2) and so the major data sets at least tell the same basic story: Rodriguez,Francisco, The Anarchy of Numbers: Understanding the Evidence on Venezuelan Economic Growth, Canadian Journal of Development Studies, Vol. 27, No. 4 (2006) [Available through the authors website at:http://frrodriguez.web.wesleyan.edu/docs/working_papers/Anarchy.pdf].
http://www.bcv.org.ve/c2/indicadores.asphttp://frrodriguez.web.wesleyan.edu/docs/working_papers/Anarchy.pdfhttp://frrodriguez.web.wesleyan.edu/docs/working_papers/Anarchy.pdfhttp://www.bcv.org.ve/c2/indicadores.asp


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more internationally, even while the volume of oil produced (which is what real oil GDP measures)is constant or declining. In fact, during the 1970s it was precisely the decline in output fromVenezuela and other OPEC nations that caused oil prices to rise. These relationships can be seen inFigure 1. From 1970 to 1985, real oil output fell by 70 percent, while consumption and non-oilGDP continued rising until 1977-78. Oil prices spiraled enormously during this period, increasing by948 percent from 1970 to 1980.

FIGURE 1

Venezuela: Real Per Capita GDP and Consumption and Oil Prices

0

50

100

150

200

250

1950

1953

1956

1959

1962

1965

1968

1971

1974

1977

1980

1983

1986

1989

1992

1995

1998

2001

2004

Index(1957=

100)

0

10

20

30

40

50

60

70

80Oil GDP

Non-Oil GDP

Total GDP

Private Consumption

Real Oil Price (right axis)

Sources: Banco Central de Venezuela (BCV); BP Statistical Review (2007); Federal Reserve Bank of St. Louis,Federal Reserve Economic Data (FRED); and authors calculations.

Oil prices collapsed beginning in 1981, and the Venezuelan economy went down with them. 6 Is thissort of unraveling ahead in Venezuela, as many analysts predict? Of course, the future of oil prices isdifficult to project. The January 8 short-term outlook of the US Energy Information Agencyprojects oil prices (WTI crude) at $87.21 per barrel for 2008 and $81.67 for 2009, compared to anactual average price of $72.3 for 2007. 7 The risks of unanticipated supply shocks seem to be mostlyon the downside, which would increase prices. Most importantly, there is the potential for adversesupply shocks from the Middle East, due to the general risk of widening war, terrorism, or rebellion

for major world suppliers in the region. However, there is always the risk of an unexpecteddownturn in oil prices. If such an unanticipated reduction in oil prices is temporary, Venezuela would seem well prepared to withstand it. The government has about $34.3 billion, or about 15percent of GDP in international reserves. This is much more than is needed to maintain a safe levelof reserves for imports or other needs. As discussed below, the country also has relatively low levelsof public and foreign public debt, and if necessary could borrow rather than cut governmentspending or public investment enough to seriously slow the domestic economy. The governmentalso budgets conservatively for oil prices that are far below current prices: for 2007, the government

6GDP peaked in 1977, but most of this downturn came after oil prices collapsed.

7Energy Information Administration (EIA), "Short-Term Energy Outlook," January 8, 2008. Available online at:

http://www.eia.doe.gov/emeu/steo/pub/contents.html.
http://www.eia.doe.gov/emeu/steo/pub/contents.htmlhttp://www.eia.doe.gov/emeu/steo/pub/contents.html


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budgeted for oil at $29 per barrel, whereas the average price of Venezuelan crude oil was $65.20 (seebelow). The probability of an economic collapse brought on by falling oil prices therefore appears tobe very small.

It is also worth noting that the current economic expansion is far greater than the 1973-1977 upturn,when oil prices were also rapidly rising. As noted above, since the first quarter of 2003, Venezuela'sreal (inflation-adjusted) GDP has grown by 87.3 percent; during the 1973-1977 expansion it grew by

31 percent. This is despite the fact that oil prices actually rose even more, and to a higher level inreal terms, from 1973-1980 than in their present climb from 1998. Although some of the recentexpansion is clearly a rebound from the 2002-2003 oil strike/recession, the vast majority of it is not(see Figure 1). Thus the current economic expansion has seen rapid growth even for an "oil boom,"and even given its recovery from the oil strike and recession. It seems likely that the government'sexpansionary fiscal and monetary policies, and perhaps other policies (e.g. exchange controls sinceFebruary 2003 which have kept more capital within the country) may have contributed to the rapidgrowth of the present expansion.

FIGURE 2

Venezuela: Real GDP (seasonally-adjusted)

6

7

8

9

10

11

12

13

14

15

1998

Q1

1998

Q3

1999

Q1

1999

Q3

2000

Q1

2000

Q3

2001

Q1

2001

Q3

2002

Q1

2002

Q3

2003

Q1

2003

Q3

2004

Q1

2004

Q3

2005

Q1

2005

Q3

2006

Q1

2006

Q3

2007

Q1

2007

Q3

Trillionsof

1997Bolivares

1998Q4:

-Chavez wins elections (Dec. 6)

-Venezuelan oil price lowest in

22 years (Dec.)

1999Q1:

-Chavez takes office (Feb. 2)

2002Q2:

-Fedecamaras calls for another

general strike (Apr. 9)

-April coup d'etat temporarily

overthrows constitutional

government (Apr. 11)

2001Q4:

-Fedecamaras (largest business

association) calls for general

strike (Dec. 9)

2002Q4:

-Oil strike cripples the

economy (Dec.)

2003Q1:

-Oil strike ends (Feb. 3)

2003Q2:

-Opposition agrees to seek

Chavez's removal through

electoral (recall) referendum

(May)

2004Q3:

-Chavez wins recall

referendum (Aug.)

Source: Banco Central de Venezuela (BCV) and authors analysis.

Figure 2 shows Venezuela's real quarterly GDP from 1998-2007 (third quarter)8. As can be seenfrom the graph, the trajectory of the economy appears to be very heavily influenced by externalshocks, especially political instability and strikes. Chvez's first year (1999), which began with theprice of Venezuelan oil at its lowest point in 22 years, was marked by negative growth. But theeconomy began to grow in the first quarter of 2000 and continued through the third quarter of 2001.The next few months were a period of the most extreme political instability: in December of 2001the Venezuelan Chamber of Commerce (FEDECAMARAS) organized a general business strikeagainst the government. This political instability, with much capital flight, continued through April2002, when the elected government was overthrown in a military coup. The constitutional

8 Seasonally adjusted.


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government was restored within 48 hours, but stability did not return, as the opposition continuedto seek to topple the government by extra-legal means. Growth remained negative through thesummer and fall of 2002, and then the economy was hit with the opposition-led oil strike ofDecember 2002-February 2003. This plunged the economy into a severe recession during whichVenezuela lost 24 percent of its GDP. The economy began to recover in the second quarter of 2003and has grown very rapidly since then.

While some macro-economic policies may have contributed to the economy's poor performance forbrief periods for example the government's temporary pro-cyclical fiscal policy at the beginning of2002 it is clear that not only the price of oil but political instability played a very large role inVenezuela's business cycles over the past eight years. After the failure of the oil strike in February2003 the opposition especially after an agreement reached with the government in May 2003 began to focus primarily on electoral means of dislodging the government. This culminated in apresidential recall referendum in August of 2004. Thus, the political situation stabilized considerablyin mid-2003 and has continued to stabilize throughout the current economic expansion.

The big upswing from the first to second quarter of 2003 was driven by the recovery of oilproduction that was cut off during the strike. But the economy's double-digit growth continued up

to the present, with the result that annual growth was 18.3 percent in 2004, 10.3 percent in 2005, and10.3 percent in 2006. This growth has been concentrated in the non-oil sector of the economy, withthe oil sector barely growing at all for 2005-2006 (seeTable 1).

As can be seen inTable 1, the private sector has grown faster than the public sector over the last 8years, and therefore the private sector is a bigger share of the economy in 2007 than it was beforePresident Chvez took office.9

Table 1 also shows the sectoral growth of Venezuela's economy over the last nine years, throughthe third quarter of 2007. The growth has all been during the current economic expansion the fouryears and a half from Q1 2003 to Q3 2007. The fastest growing sector during this period has been

finance and insurance, which grew 273.4 percent during this period. Other fast-growing sectorsincluded construction (135.1 percent), trade and repair services (148.1 percent), communications(111.6 percent) and transport and storage (103.6 percent). Manufacturing has done better than theoverall economy, with 93.9 percent growth, but this is not enough growth in this sector tocontribute to a process of serious diversification away from its dependence on oil.10

9In 2006, the private sectors total value added was 63 per cent of total GDP, up from 59 per cent in 1999. Calculationsbased on constant price GDP series from the Venezuelan Central Bank (Banco Central de Venezuela,www.bcv.org.ve(last accessed on 06/18/07).

10 This growth is also calculated using seasonally adjusted data.
http://www.bcv.org.ve/http://www.bcv.org.ve/


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TABLE 1

Venezuela: Real Sector (1998-2007) (real percent change)

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007/a

Real GDP, total 0.3 -6.0 3.7 3.4 -8.9 -7.8 18.3 10.3 10.3 8.4

Public -2.1 -5.2 3.0 -0.6 -11.1 -1.3 12.5 2.8 3.6 4.8

Private 1.1 -6.9 4.2 4.9 -5.8 -8.9 17.2 12.9 11.9 8.5

By Economic Activity

Oil Sector 0.3 -3.8 2.3 -0.9 -14.2 -1.9 13.7 -1.5 -2.0 -6.1

Non-Oil Sector -0.1 -6.9 4.2 4.0 -6.0 -7.4 16.1 12.2 11.7 9.9

Mining -7.5 -12.1 15.3 2.8 4.3 -4.4 14.2 3.0 4.5 -0.6

Manufacturing -1.4 -10.1 5.1 3.7 -13.1 -6.8 21.4 11.1 9.7 7.4

Electricity and Water Supply 0.5 -2.2 4.7 4.8 2.1 -0.5 8.5 11.2 5.8 2.9

Construction 1.4 -17.4 4.0 13.5 -8.4 -39.5 25.1 20.0 35.6 12.5

Trade and Repair Services -1.5 -5.4 5.7 4.6 -13.6 -9.6 28.6 21.0 19.1 18.3

Transport and Storage -5.2 -15.3 12.5 -1.3 -10.4 -8.0 24.6 14.7 10.0 14.5

Communications 8.2 3.6 2.1 8.1 2.5 -5.0 12.9 22.4 23.2 23.2

Financial and Insurance 0.2 -15.2 -0.7 2.8 -14.5 11.9 37.9 36.4 43.9 22.2

Real Estate 0.7 -4.7 0.8 3.5 -0.7 -6.0 11.1 7.9 8.3 7.1Community and Personal Servicesand Non-Profit 0.3 -1.7 0.9 2.1 0.1 -0.3 9.4 8.2 16.5 13.2

General Government Services -0.6 -4.8 2.8 2.5 -0.4 4.9 11.1 8.0 3.9 4.8

Other /b 3.0 0.5 5.2 1.8 -1.0 -2.9 7.2 12.6 1.9 4.5

Expenditure-Based

Government Final Consumption -3.1 -7.5 4.2 6.9 -2.5 5.7 14.2 10.7 6.7 5.0

Private Final Consumption 1.8 -1.7 4.7 6.0 -7.1 -4.3 15.4 15.7 17.9 19.1

Gross Capital Formation 4.4 -10.6 6.7 13.6 -34.0 -35.5 91.3 30.5 31.6 22.2

Exports of Goods and Services 3.5 -11.0 5.8 -3.5 -4.0 -10.4 13.7 3.8 -4.5 -3.9

Imports of Goods and Services 11.3 -9.3 12.4 14.1 -25.2 -20.9 57.7 35.2 31.1 31.1

Source: Banco Central de Venezuela (BCV)Notes:

a/ Growth in first three quarters of 2007 compared to the same three quarters in 2006.b/ Includes private agriculture, restaurants and private hotels and various public sector activities.

In subsequent sections, we will look at the trajectory of Venezuela's foreign and domestic debt,balance of payments, foreign exchange reserves, inflation, investment, government budget, andother indicators to assess whether there are any serious economic imbalances that would justify theprevailing view that the current expansion is headed for some sort of collapse. From what we seenso far, however, there is at least a prima faciecase that this is not true. Rather it appears that theVenezuelan economy was hit hard by political instability prior to 2003, but has grown steadily andquite rapidly since political stability began improving in that year.


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SocialSpending,Poverty,andEmploymentWhen evaluating the economic and social progress under the current government, it is important tomake two comparisons. One is the obvious comparison with the situation prior to the Chvezadministration, at end-1998 or the beginning of 1999. However, another comparison is alsoimportant: the period beginning with the first quarter of 2003, because that is when the governmentfirst got control over the national oil industry (Petrleos de Venezuela, S.A. -- PDVSA).

Oil production at that time amounted to about half of the government budget and three-quarters ofits export revenue. Without control over these resources and indeed when they are controlled byhostile forces seeking to use or even sabotage them in order to destabilize and/or overthrow thegovernment as happened in 2002 and 2003, it is difficult if not impossible for the government toachieve much of anything in the way of economic or social improvements. In fact, as the oil strike ofDecember 2002-February 2003 showed, it was impossible to even keep the economy afloat whilePDVSA was controlled by the opposition.

As an analogy, since the United States has no comparable sector of such importance to the economy

or government revenue, imagine that the U.S. Federal Reserve were controlled by a board ofgovernors that was determined to use its control over monetary policy and interest rates todestabilize the economy and government. Such a board could wreak havoc on the economy simplyby raising the Federal Funds rate to the level where it would induce a recession. In such a situation,it would not necessarily be fair to hold the executive branch or Congress responsible for theresultant economic destruction.

Of course, in Venezuela, looking only at the changes the first quarter of 2003 would also not beappropriate, because it would measure economic and social change from the bottom of a deeprecession. That is why it is important to look at both periods.

The Chvez government has greatly increased social spending, including spending on health care,subsidized food, and education. The state oil company alone was responsible for $13.3 billion (7.3percent of GDP) of social spending in 2006. 11

The most pronounced difference has been in the area of health care. In 1998 there were 1,628primary care physicians for a population of 23.4 million. Today, there are 19,571 for a population of27 million. In 1998 there were 417 emergency rooms, 74 rehab centers and 1,628 primary carecenters compared to 721 emergency rooms, 445 rehab centers and 8,621 primary care centers(including the 6,500 check-up points, usually in poor neighborhoods, and that are in the processof being expanded to more comprehensive primary care centers) today.12 Since 2004, 399,662 peoplehave had eye operations that restored their vision. In 1999, there were 335 HIV patients receivingantiretroviral treatment from the government, compared to 18,538 in 2006.13

The Venezuelan government has also provided widespread access to subsidized food. By 2006, therewere 15,726 stores throughout the country that offered mainly food items at subsidized prices (withaverage savings of 27 percent and 39 percent compared to market prices in 2005 and 2006,

11From PDVSA's 2006 summary of financial operations. Available online at:http://www.pdvsa.com/interface.sp/database/fichero/publicacion/1792/76.PDF.

12Ministerio del Poder Popular para la Salud, Balance del avance de los servicios asistenciales de la misin Barrio

Adentro, (February 2007):http://www.misionesbolivarianas.gob.ve/component/option,com_docman/Itemid,0/task,doc_download/gid,219/.

13Logros, febrero 2007, Sistema de Indicadores Sociales de Venezuela (SISOV), Ministerio de Planificacin yDesarrollo, available online at http://www.sisov.mpd.gob.ve/estudios/.
http://www.pdvsa.com/interface.sp/database/fichero/publicacion/1792/76.PDFhttp://www.misionesbolivarianas.gob.ve/component/option,com_docman/Itemid,0/task,doc_download/gid,219/http://www.sisov.mpd.gob.ve/estudios/http://www.sisov.mpd.gob.ve/estudios/http://www.misionesbolivarianas.gob.ve/component/option,com_docman/Itemid,0/task,doc_download/gid,219/http://www.pdvsa.com/interface.sp/database/fichero/publicacion/1792/76.PDF


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respectively).14 These plus expanded special programs for the extremely poor (e.g., soup kitchensand food distribution) benefited an average of 67 percent and 43 percent of the population in 2005and 2006 respectively.15 These do not include the 1.8 million children that were beneficiaries of aschool food program in 2006, compared with 252,000 children in 1999. 16

Access to education has also increased substantially. For example, the number of public schools inthe country has increased by 3,620 from 17,122 in the 1999/2000 school year to 20,873 in the

2004/2005 school year. By comparison, in the period between the 1994/1995 and 1998/1999school years, the number of public schools increased by 915. 17 School enrollment has also increasedat all educational levels. For example, in the period between the 1999/2000 and 2005/2006 schoolyears, gross enrollment rates for preschool have increased by 25 percent, for primary education by8.3 percent, for secondary education by 45 percent and for higher education by 44 percent. 18 Overone million people also participated in adult literacy programs.19

The government has also increased its collection of non-oil taxes on businesses,20 which had beenavoiding their taxes, as is common in most of Latin America.21

Table 2 shows the central government's social spending from 1998 to 2006. There has been a

massive increase, from 8.2 percent of GDP in 1998 to 13.6 percent for 2006. In real (inflation-adjusted) terms, social spending per person22 has increased by 170 percent over the period 1998-2006. But this does not include PDVSAs social spending, which was 7.3 percent of GDP in 2006.With this included, social spending reached 20.9 percent of GDP in 2006, at least 314 percent morethan in 1998 (in real social spending per capita).

14Ministerio de Alimentacion, Memoria y Cuenta 2006 (Annual report of the Ministry of Food/Nutrition to theNational Assembly).

15Logros, febrero 2007, SISOV, Ministerio de Planificacin y Desarrollo, available online athttp://www.sisov.mpd.gob.ve/estudios/

16Ibid.

17The data is only available for the 1994-2005 period and is from SISOV, Planteles por dependencia, (last accessed12/15/07):http://www.sisov.mpd.gob.ve/indicadores/ED0304100000000/downloads/VarED_Planteles_Total(plantelesporDep

).xls18

SISOV, Cobertura del sistema. Tasa bruta de escolaridad por nivel educativo, (last accessed on 12/15/07):http://www.sisov.mpd.gob.ve/indicadores/ED0105800000000/.

19Update on Misin Robinson (February 16, 2007), Ministerio del Poder Popular para la Comunicacin y laInformacin:

[http://www.misionesbolivarianas.gob.ve/component/option,com_docman/Itemid,0/task,doc_download/gid,223/].20

Non-oil tax revenue went from 10 percent of GDP in 1999 to 12 percent in 2006 mostly due to an increase in thecollection of income taxes (on individuals and companies) from 2 percent of GDP in 1999 to 3.2 percent in 2006.Data from Venezuelas Ministry of Finance (www.mf.gov.ve, last accessed on 06/18/07).

21See John Schmitt (2003), Is it Time to Export the US Tax Model to Latin America?, Center for Economic andPolicy Research. Available online at:http://www.cepr.net/index.php?option=com_content&task=view&id=391&Itemid=8.

22Per capita social spending is a better measure than social spendingper sebecause it takes population growth intoaccount.
http://www.sisov.mpd.gob.ve/estudios/http://www.sisov.mpd.gob.ve/estudios/http://www.sisov.mpd.gob.ve/indicadores/ED0304100000000/downloads/VarED_Planteles_Total(plantelesporDep).xlshttp://www.sisov.mpd.gob.ve/indicadores/ED0304100000000/downloads/VarED_Planteles_Total(plantelesporDep).xlshttp://www.sisov.mpd.gob.ve/indicadores/ED0105800000000/http://www.misionesbolivarianas.gob.ve/component/option,com_docman/Itemid,0/task,doc_download/gid,223/http://www.mf.gov.ve/http://www.cepr.net/index.php?option=com_content&task=view&id=391&Itemid=8http://www.cepr.net/index.php?option=com_content&task=view&id=391&Itemid=8http://www.mf.gov.ve/http://www.misionesbolivarianas.gob.ve/component/option,com_docman/Itemid,0/task,doc_download/gid,223/http://www.sisov.mpd.gob.ve/indicadores/ED0105800000000/http://www.sisov.mpd.gob.ve/indicadores/ED0304100000000/downloads/VarED_Planteles_Total(plantelesporDep).xlshttp://www.sisov.mpd.gob.ve/indicadores/ED0304100000000/downloads/VarED_Planteles_Total(plantelesporDep).xlshttp://www.sisov.mpd.gob.ve/estudios/


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TABLE 2

Venezuela: Central Government Social Spending (1998-2006)/a

1998 1999 2000 2001 2002 2003 2004 2005 2006

Total Public Spending 23.7 24.5 29.6 31.6 29.4 31.0 28.4 28.5 31.0

Total Social Spending 8.2 9.4 11.0 12.1 11.2 12.1 11.8 11.6 13.6

Education 3.4 4.1 4.5 4.8 4.8 4.6 4.8 4.1 5.1Health 1.4 1.5 1.4 1.5 1.7 1.5 1.6 1.6 1.8

Housing 1.0 0.8 1.7 1.0 0.8 1.1 0.6 1.3 1.6

Social Security 1.4 2.0 2.2 3.4 2.8 3.4 3.1 3.0 3.6

Social Development and Participation 0.8 0.9 0.8 0.9 0.8 1.1 1.2 0.9 1.0

Culture and Social Communication 0.2 0.1 0.2 0.2 0.1 0.3 0.3 0.3 0.3

Science and Technology 0.1 0.1 0.2 0.3 0.1 0.1 0.3 0.3 0.2Social Spending (% of Public Spending) 34.7 38.5 37.3 38.4 38.2 39.0 41.4 40.6 44.0

Source: Sistema de Indicadores Sociales de Venezuela (SISOV) and Banco Central de Venezuela (BCV)Notes:/a Does not include social spending by PDVSA, the state oil company, which in 2006 contributed $13.3 billion (or7.3 percent of GDP) to social projects

The poverty rate has been cut in half from its peak of 55.1 percent in 2003 to 27.5 percent for thefirst half of 2007, as would be expected in the face of the very rapid economic growth during theseyears.Table 3 shows the poverty rate since 1997, by household and population. If we compare thepre-Chvez poverty rate (43.9 percent) with the first half of 2007 (27.5 percent) this is a 37.4 percentdrop in the rate of poverty, which is substantial.23 However this poverty rate measures only cashincome it does not take into account the increased access to health care or education that poorpeople have experienced. As we have shown previously, taking the most conservative estimate ofjust the value of the health care benefits what the poor would have spent on health care in theabsence of these new programs would lower the measured poverty rate by about 2 percentagepoints.24 Of course, this is a very conservative estimate of the value of just the increased health care

benefits to the poor, since in the absence of these benefits, most poor people would simply havegone without health care, and therefore suffer from worse health, lower income, and lower lifeexpectancy. So the value of these health care services is much greater than the amount that theywould have spent out-of-pocket in the absence of the government programs. 25 The situation of thepoor has therefore improved significantly beyond even the substantial poverty reduction that isvisible in the official poverty rate, which measures only cash income.

23It is worth noting that the economy has continued to grow during the second half of last year (since the last survey),so poverty would probably be somewhat lower today.

24Weisbrot, Sandoval and Rosnick (2006). Poverty Rates in Venezuela: Getting the Numbers Right, Center forEconomic and Policy Research (CEPR), Washington, DC:[http://www.cepr.net/documents/venezuelan_poverty_rates_2006_05.pdf]: see Table 2 and text.

25The alternative would be to estimate the market value of health care services received, but this would exaggerate theimpact of health care on the actual situation of the poor; we have therefore used the conservative estimate describedabove as a lower bound of the impact of this health care spending on the poor. (see Weisbrot, Sandoval and Rosnick,2006).


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TABLE 3

Venezuela: Poverty Rates (1997-2007)

Households Population

(% of total declared) (% of total declared)

Year Time Period PoorExtremelyPoor Poor

ExtremelyPoor

1st Half 55.6 25.5 60.9 29.51997

2nd Half 48.1 19.3 54.5 23.4

1st Half 49 21 55.4 24.71998

2nd Half 43.9 17.1 50.4 20.3

1st Half 42.8 16.6 50 19.91999

2nd Half 42 16.9 48.7 20.1

1st Half 41.6 16.7 48.3 19.52000

2nd Half 40.4 14.9 46.3 18

1st Half 39.1 14.2 45.5 17.42001

2nd Half 39 14 45.4 16.9

1st Half 41.5 16.6 48.1 20.12002

2nd Half 48.6 21 55.4 251st Half 54 25.1 61 30.2

20032nd Half 55.1 25 62.1 29.8

1st Half 53.1 23.5 60.2 28.12004

2nd Half 47 18.6 53.9 22.5

1st Half 42.4 17 48.8 20.32005

2nd Half 37.9 15.3 43.7 17.8

1st Half 33.9 10.6 39.7 12.92006

2nd Half 30.6 9.1 36.3 11.1

2007 1st Half 27.5 7.6 33.1 9.4

Source: Instituto Nacional de Estadstica (INE), Repblica Bolivariana de Venezuela.

In evaluating government policy with respect to poverty, it is also worth noting that the sharp spikein the poverty rate at the end of 2001 (39 percent) to its peak of 55.1 percent in the second half of2003 is overwhelmingly attributable to the opposition oil strike of 2002-2003. There is little doubtthat poverty would be even lower today if not for the enormous economic damage caused by thisstrike. Unemployment has also dropped sharply during the current economic recovery. As can beseen inTable 4, the unemployment rate has fallen from 19.2 percent in the first half of 2003 to 9.3percent in the first half of 2007, 26 its lowest level in more than a decade. If we compare to thebeginning of the Chvez administration, unemployment stood at 15.3 percent in the first half of1999. By any comparison, the official unemployment rate has dropped sharply. Of course, anunemployment rate of 9.3 percent in Venezuela, as in developing economies generally, is not

comparable to the same rate in the United States or Europe. Many of the people counted asemployed are very much underemployed. But the measure is consistent over time, and thereforeshows a considerable improvement in the labor market. This can be seen in other labor marketindicators. For example, employment in the formal sector has increased to 6.17 million (2007 firsthalf), from 4.40 million in the first half of 1998 and 4.53 million in the first half of 2003. As apercentage of the labor force, formal employment has increased significantly since 1998, from 45.4to 50.6 percent (2007).

As can be seen inTable 4, there has been an increase of about 1.8 million jobs in the private sectorand 578 thousand jobs in the public sector since the first half of 1999. Perhaps most importantly,

26The data are not seasonally adjusted, so we are comparing unemployment rates for the same period across years.


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employment as a percentage of the labor force has increased by 6 percentage points since the firsthalf of 1999, which is quite substantial. (Since 2003, it has increased by almost 10 percentage points).Private employment was also a larger percentage of the labor force (75.0 percent) in the first half of2007 as compared to the first half of 1999 (71.6 percent). However, both of these indicatorsprobably understate the improvement in the labor market since the number of people who were outof the labor force for education as access to education was increasing rose by more than 3.4

percentage points, relative to the labor force, during this period.

TABLE 4

Venezuela: Labor Force Indicators (1998-2007)/a

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

(in thousands)

Labor Force 9,699.3 10,259.2 10,163.9 10,576.0 11,369.0 11,793.5 12,036.3 11,936.5 12,056.5 12,211.8

Total Employed 8,605.1 8,691.4 8,682.7 9,123.5 9,611.7 9,524.8 10,035.7 10,344.1 10,783.2 11,079.7

Public Sector 1,402.6 1,348.2 1,352.8 1,378.4 1,364.8 1,371.3 1,491.7 1,633.6 1,804.8 1,926.2

Private Sector 7,202.5 7,343.3 7,329.9 7,745.1 8,246.9 8,153.4 8,544.0 8,710.6 8,978.4 9,153.5

Formal Sector 4,403.9 4,253.7 4,110.9 4,491.9 4,752.5 4,528.8 4,923.2 5,387.1 5,853.4 6,173.9 Informal Sector 4,147.4 4,435.0 4,565.7 4,630.1 4,856.1 4,988.4 5,108.8 4,924.2 4,929.7 4,803.1

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

(% of total labor force)

Labor Force 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Total Employed 88.7 84.7 85.4 86.3 84.5 80.8 83.4 86.7 89.4 90.7

Public Sector 14.5 13.1 13.3 13.0 12.0 11.6 12.4 13.7 15.0 15.8

Private Sector 74.3 71.6 72.1 73.2 72.5 69.1 71.0 73.0 74.5 75.0

Formal Sector 45.4 41.5 40.4 42.5 41.8 38.4 40.9 45.1 48.6 50.6

Informal Sector 42.8 43.2 44.9 43.8 42.7 42.3 42.4 41.3 40.9 39.3

Unemployment Rate 11.3 15.3 14.6 13.7 15.5 19.2 16.6 13.3 10.6 9.3

Source: Instituto Nacional de Estadstica (INE), Repblica Bolivariana de VenezuelaNotes:a/ Data correspond to the first half of every year (from INE's biannual Household Survey)


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FiscalandMonetaryPolicy,ExchangeRates,BalanceofPayments,andtheSustainabilityoftheCurrentEconomicExpansion As noted previously, one of the most persistent themes in reporting on, and discussion of, Venezuela's current economic expansion is that it is an oil boom headed for collapse. Althoughsome of these statements rely on a drop in oil prices as the trigger for Venezuela's economiccollapse, many such prognostications offer little in the way of concrete explanation as to what willbring the current expansion to a halt. 27 This is quite different from predicting, for example in theUnited States at the peak of the 1990's stock market bubble, that stock prices would fall sharply andthat this loss of wealth would cause a recession (as did actually happen). Or that the housing bubble,which appears to have peaked in July 2006, would have to burst and that this deflation (through thewealth effect and credit impacts of falling home prices, a shrinking construction sector, etc.) willcause a recession. In these cases one can estimate the overvaluation of asset prices, the size of theexpected correction, and the expected impact of such a correction on the economy. 28 But given thevagueness of this popular conception of Venezuela's expected economic troubles, it is not possible

to address the argument with this kind of specificity; however, it is possible to look at theVenezuelan economy and see if there are any serious economic imbalances that threaten to cut shortthe current economic expansion.

Venezuela has budgeted conservatively with respect to the price of oil, and the prospect of acollapse in oil prices in the foreseeable future seems unlikely as described above. Critics also pointto the run-up in government spending as an unsustainable trend. Table 5 shows the government'sfinances since 1998. As can be seen, there has indeed been a very large increase in centralgovernment spending, from 21.4 percent of GDP in 1998 to 30 percent in 2006. However, revenuesincreased even more, from 17.4 to 30 percent of GDP over the same period, leaving the centralgovernment with a balanced budget for 2006. For 2007, the government has once again budgeted

very conservatively for oil at $29 per barrel, 56 percent under the average $65.20 dollars per barrelthat Venezuelan crude sold for last year. For 2008, the government has assumed a price of $35 perbarrel. However, what the government generally does as oil revenue far exceeds the budgeted price,is to spend beyond budgeted expenditures. Thus, while a fall in oil prices will not cause a budgetarycrisis, it could lead to reduced government spending from current levels. This could slow theeconomy from its present very rapid pace, but it is unlikely to cause a downturn, because Venezuelahas a considerable cushion to deal with a decline in oil prices.

As can be seen inTable 5 and Table 6, Venezuela has taken advantage of the current expansionand increased oil revenues to reduce its public debt, and especially foreign public debt. Total publicdebt increased quite substantially through the crisis of 2002-2003, reaching a peak of 47.7 percent ofGDP in 2003. But by 2006 it was down to a modest 24.3 percent of GDP. The government also

27For example, Domingo Maza Zavala, then director of the Central Bank, warned theNew York Timesin October 2005of a recession as soon as 2007, without offering an explanation of how this might happen (Juan Forero, ChvezRestyles Venezuela With '21st-Century Socialism, The New York Times. October 30, 2005,). Also, the InternationalMonetary Fund has projected a drastic growth slowdown for three consecutive years, which has not materialized. SeeTable 2 in David Rosnick and Mark Weisbrot (2007), Political Forecasting? The IMFs Flawed Growth Projectionsfor Argentina and Venezuela, Center for Economic and Policy Research. Available online at:http://www.cepr.net/index.php?option=com_content&task=view&id=1107 ].

28See, for example, Dean Baker (2000), Double Bubble: The Implications of the Over-Valuation of the Stock Marketand the Dollar, Center for Economic and Policy Research. [Available online:http://www.cepr.net/documents/publications/double_bubble.pdf] and; Dean Baker and David Rosnick (2005) Willa Bursting Bubble Trouble Bernanke?: The Evidence for a Housing Bubble, Center for Economic and PolicyResearch. [Available online: http://www.cepr.net/documents/publications/housing_bubble_2005_11.pdf]
http://www.cepr.net/documents/publications/double_bubble.pdfhttp://www.cepr.net/index.php?option=com_content&task=view&id=1072http://www.cepr.net/index.php?option=com_content&task=view&id=1072http://www.cepr.net/documents/publications/double_bubble.pdf


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transitioned away from foreign financing, leaving the external component of the foreign debt at just15.0 percent of GDP. Total interest payments on the public debt, foreign and domestic, summed toa relatively small 2.1 percent of GDP in 2006.

TABLE 5

Venezuela: Central Government Finances (1998-2006) (in percentage of GDP)/1

1998 1999 2000 2001 2002 2003 2004 2005 2006

Total Revenue 17.4 18.0 20.2 20.8 22.2 23.4 24.0 27.7 30.0

Current Revenue 17.4 18.0 20.2 20.8 22.2 23.4 24.0 27.7 30.0

Tax Revenue 12.2 13.0 12.9 11.4 10.6 11.3 12.7 15.3 15.8

Oil 1.3 2.2 4.2 2.5 0.9 1.5 1.8 3.7 3.9

Non-Oil 10.9 10.8 8.6 8.9 9.7 9.8 10.9 11.6 12.0

Non-Tax Revenue 5.2 5.0 7.3 9.4 11.5 12.1 11.3 12.3 14.2

Oil 4.5 4.4 5.8 6.9 9.6 10.1 9.4 9.8 12.0

Non-Oil 0.8 0.6 1.5 2.5 2.0 2.0 1.9 2.6 2.2

Total Expenditure and Net Lending 21.4 19.8 21.8 25.1 26.1 27.8 25.9 26.0 30.0

Current Expenditure 16.7 16.4 17.5 19.3 19.1 20.8 19.6 19.1 22.2

Capital Expenditure 4.0 3.0 3.3 4.4 5.1 5.5 5.0 5.8 6.7

Off-Budget Expenditure and Net

Lending 0.7 0.4 1.0 1.5 2.0 1.5 1.3 1.1 1.1

Primary Balance -1.4 1.0 0.9 -1.5 0.6 0.3 1.8 4.6 2.1

Overall Balance -4.0 -1.7 -1.7 -4.4 -4.0 -4.4 -1.9 1.6 0.0

Financing 4.0 1.7 1.7 4.4 4.0 4.4 1.9 -1.6 0.0

Domestic 2.8 2.8 4.0 4.0 3.1 3.3 -0.7 -2.5 -1.3Foreign 1.2 -1.1 -2.3 0.3 0.9 1.1 2.6 0.9 1.3

Source: Ministerio del Poder Popular para las Finanzas (MF), Repblica Bolivariana de Venezuela.Notes: /1 Latest data available. Subject to revision.

Thus there is plenty of room to borrow, if necessary, if Venezuela were to face an unexpecteddecline in oil revenues. But before having to borrow, the government could dip into its internationalreserves. As can be seen inTable 6 (below), the government's foreign exchange reserves by the endof 2007 were $34.3 billion, or about 15 percent of GDP. Also, if we add the offshore accounts ofthe FONDEN and the National Treasury to the current level of international reserves, the total is inexcess of $50 billion. The government's revenue from oil in 2006 was $28.9 billion. In the face of anunanticipated decline in oil prices, the government could therefore draw on reserves and borrowing

from financial markets for some time before any serious budget cuts would be necessary. Forexample, if oil revenue were to decline by as much as 30 percent, this could be absorbed fromreserves, which would otherwise be expected to grow over the next year.

Another common feature of the "oil boom to be followed by bust" analysis of Venezuela's economyis that government spending is fueling rapidly rising inflation, which will spin out of control.According to this theory, which also is not well specified, either the inflation itself would cause acrisis e.g. become hyperinflation or the government would be forced to put the economy into asharp contraction in order to avoid or reduce dangerous levels of inflation.


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TABLE 6

Venezuela: Selected Economic Indicators (1998-2007)

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

(in % of GDP)

Current Account -4.9 2.2 10.2 1.6 8.4 14.2 13.8 17.8 14.9 7.0

Trade balance in goods 1.0 6.6 14.3 6.1 14.8 20.2 20.2 22.1 18.0 8.3

Exports, fob 19.5 21.5 28.7 21.8 29.6 32.9 35.3 38.9 35.9 21.8

Oil 13.4 17.2 23.9 17.8 23.8 26.6 29.3 33.6 32.2 19.5

Non-Oil 6.1 4.3 4.8 4.0 5.8 6.3 6.1 5.3 3.7 2.3

Imports, fob -18.4 -14.9 -14.4 -15.7 -14.8 -12.7 -15.2 -16.8 -17.9 -13.5

Oil -1.6 -1.5 -1.5 -1.5 -1.4 -1.6 -1.6 -1.7 -1.5 -1.0

Non-Oil -16.8 -13.4 -13.0 -14.2 -13.3 -11.0 -13.6 -15.1 -16.4 -12.5

Trade balance in services -2.9 -2.9 -2.8 -2.7 -3.2 -3.2 -3.0 -2.8 -2.4 -1.7

(in % of GDP)

Gross Public Debt

Total 30.7 29.6 27.7 30.7 39.9 47.8 38.5 32.9 24.3 17.8

Foreign 25.6 23.2 18.6 18.4 24.9 29.9 24.5 21.8 15.0 11.4

Domestic 5.1 6.5 9.1 12.4 15.0 17.9 14.0 11.1 9.3 6.4

(in % of GDP)

Gross Capital Formation

Total 30.7 26.5 24.2 27.5 21.2 15.2 21.8 22.6 24.7

Public 12.2 8.0 6.1 6.5 9.3 8.3 9.1 8.1

Private 18.5 18.5 18.0 21.0 11.9 6.9 12.7 14.9

Gross Fixed Capital Formation 28.6 23.7 21.0 24.1 21.9 15.5 18.3 20.2 22.5

Change in Inventories 2.1 2.8 3.2 3.5 -0.8 -0.3 3.5 2.4 2.2

(real % change)

Total 4.4 -10.6 6.7 13.6 -34.0 -35.5 91.3 30.5 31.6 22.2

Gross Fixed Capital Formation 5.5 -15.6 2.6 13.8 -18.4 -37.0 49.7 38.4 26.6 24.6

Other

Nominal GDP (US$ millions) 90,946 97,476 116,758 122,448 90,554 82,801 112,333 143,319 181,608 227,826

Average exchange rate (VEB per USD) 550 609 682 726 1,191 1,621 1,893 2,112 2,150 2,150Average inflation rate, consumer prices(%) 35.8 23.6 16.2 12.5 22.4 31.1 21.7 16.0 13.7 18.7Gross International Reserves (US$millions) 14,849 15,379 20,471 18,523 14,860 21,366 24,208 30,368 37,440 34,309

Sources: Banco Central de Venezuela (BCV); Ministerio del Poder Popular para las Finanzas (MF), Repblica

Bolivariana de Venezuela.Notes:a/ First three quarters of 2007. Not on an annual basis.b/ Balance as of September 30, 2007.c/ First three quarters of 2007 in 1997 constant prices, compared to the same period in the previous year.d/ Projections based on preliminary estimates for 2007.e/ As of December 31, 2007.f/ Annual average.g/ As of December 31, 2007.


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Figure 3 shows Venezuela's monthly year-over-year inflation rate since 1991. As can be seen in thegraph, inflation declined steadily from May 1998 to January 2002, from a 40 percent to a 12 percentannual rate. It then rose rapidly during Venezuela's worst political instability, from February 2002 toFebruary 2003. This period included the military coup of April 2002 and most importantly, the oilstrike of December 2002 to February 2003, which generated major supply shortages and pushedinflation back up to a 40 percent annual rate. After the strike ended, inflation declined steadily again

for the next three and a half years, despite the rapid growth during recovery that began in the fourthquarter of 2003. But since June 2006 there has been another upswing, pushing the year-over-yearinflation rate from 10.4 percent to 22.5 percent (December 2007).

FIGURE 3

Venezuela: Monthly Inflation Rate, Consumer Prices (January 1991 - December 2007)

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

120.0%

140.0%

Jan-91

Jan-92

Jan-93

Jan-94

Jan-95

Jan-96

Jan-97

Jan-98

Jan-99

Jan-00

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Year-over-year,%c

hange

Source: Banco Central de Venezuela (BCV)

The current uptick in inflation is fueled by a combination of shortages and the accumulated effectsof four and a half years of very rapid growth. How serious of a problem is this increased inflation,and could it lead to an economic crisis and/or the end of the current economic expansion? First, itshould be kept in mind that there is no consensus in the macroeconomic research on inflation as tohow high it can go without a negative impact on growth, with some studies finding a threshold of 20

percent or more a threshold that Venezuela is just now passing.29

Second, it should be emphasizedthat double-digit inflation rates in a developing country such as Venezuela are not comparable to thesame phenomenon occurring in the United States or Europe. Inflation in Venezuela was muchhigher in the pre-Chvez years, running at 36 percent in 1998 and 100 percent in 1996. Althoughmuch of the public does not understand this, it is real (after-inflation) growth in incomes andemployment that affects people's living standards, not the rate of inflation per se. This is true so

29See, for example, Michael Bruno (1995), Does Inflation Really Lower Growth? Finance and Development, September;Michael Bruno and William Easterly (1998), Inflation Crises and Long-Run Growth,Journal of Monetary Economics, 41,pp. 3-26; and Robert Pollin and Andong Zhu (2005), Inflation and Economic Growth: A Cross-Country Non-linearAnalysis, Political Economy Research Institute, Working Paper Series No. 109: University of Massachusetts, Amherst[Available online: http://www.peri.umass.edu/fileadmin/pdf/working_papers/working_papers_101-150/WP109.pdf].


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long as inflation does not spiral to the point where it actually reduces real growth. So far, it does notappear that inflation in Venezuela is getting out of control.

Furthermore, since the country is running such a large current account surplus, and the governmentis taking in more revenue that it can spend, it has a number of tools to fight inflation withoutnecessarily sacrificing economic growth. One has been sterilization, whereby the government takesexcess domestic currency out of circulation by issuing bonds. The recent sale of $7.5 billion worth

of bonds by PDVSA in April, which were snapped up by a large number of investors, 30 are anexample of the government using bond sales for this purpose. Venezuela's current account surplusalso gives it the leeway to defuse inflation through imports. This is what happened through most ofthe current economic recovery, when inflation was falling despite very rapid growth excessdomestic currency was converted into dollars and spent on imports. As can be seen in Table 6,imports tripled from their depressed level of $10.5 billion in 2003 to $32.5 billion, or 17.9 percent ofGDP in 2006. But exports, fueled by rising oil prices and the recovery of oil production from thestrike, grew much faster, from $27.2 billion in 2003 to $65.2 billion, or 36 percent of GDP. As aresult, the country has been running a huge current account surplus: it was 15 percent of GDP for2006. In the first three quarters of 2007 this surplus has shrunk considerably, but is still about 7percent of GDP.

In sum, inflation has been rising over most of last year but it is not an imminent threat to the currentexpansion. This is likely to remain the case so long as Venezuela maintains a large current accountsurplus. Nonetheless, the government will need to make sure that inflation does not begin anotherupward climb of the sort that has happened over the last year. Fortunately, given the government'sfavorable current account, international reserves and borrowing capacity, it has the ability to bringdown inflation without a sharp slowdown in economic growth.

There have also been reports of shortages of foods such as beef, sugar, corn oil, milk, chicken andeggs. In most cases these foods can be purchased in various black markets when they are unavailablein supermarkets and the Mercal centers. These shortages are generally believed to be at least partly aresult of price controls, the rapid growth of the economy and consumption, as well as hoarding of

some items. While this may become a political problem if it persists or worsens, it is something thatthe government can easily mitigate. Even more so than in the case of inflation, the government hasthe ability to ease any shortages through imports, and presumably would do so if there were aserious threat of economic or political damage.

The most serious economic imbalance is the exchange rate. The bolivar is pegged at 2,150 to thedollar; it was fixed at 1,600 in February 2003 when the government implemented foreign exchangecontrols. If we assume that the currency was neither overvalued nor undervalued when the exchangecontrols were implemented more likely it was already overvalued we would expect adepreciation to about 3,182 as a result of Venezuela's inflation. 31 Thus the Venezuelan currency is atleast 32.4 percent overvalued relative to the dollar. It is worth noting that this is not necessarily

overvalued to the extent indicated by the parallel market rate, where the currency has depreciatedrapidly over the last year, to more than 6,000 bolivares per dollar. Nonetheless the currency is stillsignificantly overvalued. This is something that will have to be remedied if Venezuela is going topursue a long-term development strategy that diversifies the economy away from oil. An overvaluedcurrency discourages the development of non-oil sectors, especially manufacturing. It makes importsartificially cheap and the country's exports more expensive on world markets, thus putting the

30Benedict Mander, PdVSA Issue Proves a Pioneer in the Democratisation of Capital, Financial Times, April 12, 2007.

31This is based on the ratio of Venezuela's cumulative consumer price inflation since February 2003, which is 128.5percent, to U.S. inflation of 14.9 percent.


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country's tradable goods at a serious disadvantage in both international and domestic markets. 32 Thisis a serious long-term development problem. There are also distortions and inefficiencies associatedwith the system of exchange controls and the parallel market.

The overvalued fixed exchange rate, combined with present levels of inflation, also presents asignificant intermediate-term problem. Even if inflation is stabilized and begins to be reduced, so

long as it remains at or near current levels and the nominal exchange rate remains fixed, Venezuela'scurrency will become increasingly overvalued. This will increasingly squeeze domestic productionoutside of oil and non-tradables, and would eventually become unsustainable.

Nonetheless, Venezuela's overvalued exchange rate does not present the kind of immediate threatthat e.g., overvalued exchange rates in Argentina, Mexico, Brazil, or Russia presented in the 1990's,where a sudden and forced devaluation was imminent. The cost of adjustment in such situations canbe quite significant, as it was in Argentina and Mexico. But the Venezuelan government has anumber of options for bringing the currency to a more competitive level over time, given its largecurrent account surplus. The government is understandably reluctant to devalue at present, when itis trying to stabilize an inflation rate that has risen sharply over the last year. But it is a problem thatmust be dealt with sooner or later.

FIGURE 4

Venezuela: Real Monthly Interest Rates (Annualized)

-20

-10

0

10

20

30

40

Jan-98

Jul-9

8

Jan-99

Jul-9

9

Jan-00

Jul-0

0

Jan-01

Jul-0

1

Jan-02

Jul-0

2

Jan-03

Jul-0

3

Jan-04

Jul-0

4

Jan-05

Jul-0

5

Jan-06

Jul-0

6

Jan-07

Jul-0

7

%

Lending Rate

Deposit Rate (90 days)

Source: Banco Central de Venezuela (BCV) and authors calculations

Real interest rates have been negative throughout the recovery as measured by the 90-day depositrate, or most of the recovery (as measured by the lending rate33). This is shown in Figure 4. Theselow interest rates, combined with the government's expansionary fiscal policy, have no doubt

32The phenomenon of resource-exporting countries having overvalued currencies and the harmful results of such

overvaluation are sometimes called "Dutch disease," from the experience of the Netherlands after the discovery ofnatural gas there in the 1960s.

33The lending rate is a weighted average of the rates charged on promissory notes and loans made by commercial banksand universal banks.


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contributed to the economy's rapid growth since the fourth quarter of 2003. It is worth noting thatthe government's currency controls, originally enacted in February 2003 as a means of limitingcapital flight from the country, have enabled it to pursue expansionary fiscal and monetary policieswhile maintaining a fixed exchange rate. Thus the overall combination of macroeconomic policy hasbeen successful at promoting rapid growth, although with an increasingly overvalued real exchangerate.

Finally, another recurring theme is that Venezuela's economic growth will be cut short from a lackof investment, as investors both foreign and domestic perceive the economy to be anunfavorable investment climate.Table 6 also shows gross capital formation and gross fixed capitalformation since 1998. As can be seen from the totals, gross fixed capital formation stagnated from1998-2001 and collapsed by 57 percent during the worst instability and oil strike of 2002-2003.However, it has grown enormously during the current economic expansion. It rebounded sharply in2004, growing by 49.7 percent year-over-year in real terms. It has continued its rapid growth throughthe present, increasing by 38.4 percent in 2005, and 26.6 percent in 2006. For the first three quartersof 2007, gross capital formation is up 24.6 percent year-over-year.

These figures do not separate public and private investment. Data for gross capital formation which

does make this separation is available through 2005. In that year, gross private capital formationrepresented 14.9 percent of GDP, an increase from 12.7 percent in 2004 and 6.9 percent in 2003,indicating an increasing share of private investment in the economy during this period. It is possiblehowever, that private investment has not kept pace with the growth of public investment after 2005. We do know from Central Bank balance of payments data that foreign direct investment inVenezuela was negative for the year 2006, for the first time in eight years of the Chvez government.This is a significant change, although not that large, as foreign direct investment in Venezuela wasabout 1.8 percent of GDP in 2005. But we do not know yet how much of the growth in total orfixed capital formation of the last two years has been private versus public.

But even if private investment is lagging, public sector investment has been badly neglected fordecades and there is much potential there to improve the productivity of the economy as was most

famously demonstrated by the collapse, and then recent repair of the Viaduct 1 bridge that was avital part of the route from the La Guaira airport to Caracas. If private investment does not keep upwith the economy's rapid growth, it is not clear that this will necessarily slow Venezuela's growthand development.

In 2006, the government nationalized the telecommunications giant CANTV and some of thecountry's electricity generation (which was already more than 80 percent in the hands of thegovernment). It has also taken a majority stake in its joint ventures with foreign oil companies in theOrinoco basin. These moves have generally been portrayed as very negative not only for Venezuela'sinvestment climate but also for its economic future.


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However, it is important to keep some perspective on these changes. The telecommunications sectorwas nationally owned and then privatized in the 1990s. Companies were compensated fully for theirassets: "I think this deal is a fair one," AES chief executive Paul Hanrahan said at a news conference inCaracas adding that negotiations had "respected the rights of investors."34 CANTV has a near-monopoly on land phones and Internet service, and has been slow to expand access Venezuela'sInternet access remains below average for the region, with 125 users per 1000 people, as compared to

156 for Latin America.

35

(This is particularly bad because Venezuela is far above average in per capitaincome for the region).

In the oil sector, the first round of negotiations were settled for 31 of 33 contracts, with only FrancesTotal and Italys ENI choosing to leave. Last year, most of the remaining joint ventures were alsorenegotiated, but Exxon-Mobil and ConocoPhillips announced that they had rejected thegovernment's offer and would pull out. Venezuela is one of the only major oil-producing states in thedeveloping world that allows foreign investment in oil production even US allies such as Mexico andSaudi Arabia, for example, do not. Venezuela's reserves of heavy crude in the Orinoco region are nowestimated to be among the largest in the world, so foreign companies have strong incentives to stayinvolved. They also face increasing competition from state-run companies from countries such asChina, Brazil, India, Russia, and elsewhere.

In sum, the Venezuelan government's moves toward increased state involvement in the economy havenot involved large-scale nationalizations or state planning, and have been careful not to take onadministrative functions that are beyond its present capacity. As noted above, the government has noteven increased the public sector's share of the economy. The central government's spending, at 30percent of GDP, is far below such European capitalist countries as France (49 percent) or Sweden (52percent). There is still plenty of room for both private and public investment.

34Steven Mufson, AES to Sell Utility Stake To Venezuela; Chvez's State-Control Plan Nets Electric Firm, The

Washington Post, February 9, 2007.35 Source: World Bank, World Development Indicators Online, last accessed on 06/06/2007.


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ConclusionIn sum, the performance of the Venezuelan economy during the Chvez years does not fit the moldof an "oil boom headed for a bust." Rather it appears that the economy was hit hard for the first fewyears by political instability, and has grown rapidly since the political situation stabilized in the firstquarter of 2003. High oil prices have certainly contributed to this growth, as has the government's

expansionary fiscal and monetary policy. Containing and reducing inflation, as well as realigning thedomestic currency, appear to be the most important challenges in the intermediate run; in the longrun, diversifying the economy away from its dependence on oil is also a major challenge.

However, the declining public debt (as a percentage of GDP), the large current account surplus, andthe accumulation of reserves have given the government considerable insurance against a decline inoil prices. This favorable macroeconomic situation has also left the government with much flexibilityin dealing with inflation and the related imbalance in the exchange rate. Since the government iscommitted to maintaining solid growth, it does not seem likely that it would sharply curtaileconomic growth in order to bring down inflation, as is often done. This is especially true since ithas not exhausted other alternatives. Venezuela is also well-situated to withstand negative external

shocks, including a likely U.S. recession or even a serious global slowdown, a significant drop in theprice of oil, and problems in the international credit and financial system. Therefore, at present itdoes not appear that the current economic expansion is about to end any time in the near future.The gains in poverty reduction, employment, education and health care that have occurred in thelast few years are likely to continue along with the expansion.

update: the venezuelan economy in the chavez years

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